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Issues Involved:
1. Deduction of penalty as allowable expenditure. 2. Nature of the obligation to export sanforized cloth. 3. Contingent liability versus ascertained liability. 4. Commercial loss versus penalty for infraction of law. Issue-wise Detailed Analysis: 1. Deduction of Penalty as Allowable Expenditure: The primary issue was whether the Tribunal was correct in allowing the deduction of penalties amounting to Rs. 50,651 for the assessment year 1967-68 and Rs. 67,801 for the assessment year 1968-69. The Income Tax Officer (ITO) initially disallowed these deductions, arguing that the penalties were not expended for the purposes of the assessee's business or incidental to it. However, the Appellate Assistant Commissioner (AAC) and the Tribunal later allowed these deductions, considering them as liabilities arising during the normal trading activities of the assessee. 2. Nature of the Obligation to Export Sanforized Cloth: The obligation to export a certain percentage of sanforized cloth was based on an agreement regarding the use of the Sanforized Trade Mark of M/s. Cluett Peabody & Company. The ITO initially treated this obligation as a contractual one, asserting that the breach of this contractual obligation could not be considered a normal trading activity. However, the Tribunal found that the payments made for the breach of this obligation were incidental to the business and arose during the normal trading activities of the assessee. The court noted that the obligation was not statutory but contractual, and thus, the failure to export did not amount to an act against public policy or a contravention of statutory provisions. 3. Contingent Liability versus Ascertained Liability: The revenue argued that the disputed claim was a contingent liability because the assessee could make good the shortfall in subsequent years. However, the court found that the liability for the penalty arose annually and was an ascertained liability. Clause (v) of the letter dated April 30, 1966, required mills to deposit the penalty amount in the government account annually if they failed to meet the export obligation. This made the liability present and ascertained, not contingent. 4. Commercial Loss versus Penalty for Infraction of Law: The court distinguished between commercial loss and penalties for the infraction of law. It referred to the Supreme Court's decision in Haji Aziz and Abdul Shakoor Bros. v. CIT, which stated that penalties for breach of law cannot be considered commercial losses. However, the court found that the payments made by the assessee were not penalties for statutory infractions but were damages for breach of a contractual obligation. These payments were considered commercial losses as they were incidental to the business and necessary for carrying on the business of manufacturing sanforized cloth. The court also referred to several precedents, including decisions from the Gujarat High Court and the Supreme Court, which supported the view that such payments, though termed as penalties, were in reality commercial losses connected with the business and hence deductible. Conclusion: The court concluded that the disputed payments were commercial losses and allowable deductions under Section 28(i) of the Income Tax Act. The liability was ascertained, arose annually, and was necessary for the business. Therefore, the Tribunal was correct in allowing the deductions for the assessment years 1967-68 and 1968-69. The court answered the question in the affirmative, against the department, and in favor of the assessee, awarding costs to the respondent assessee.
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